163. Management is currently deciding whether or not to investigate a cost variance that was
identified by the accounting system. To help address this question, you have generated the
following data:
Possible States of Nature:
1. The underlying operation is in control (i.e., is operating normally).
2. The underlying operation is out of control (and therefore is in need of an intervention).
Possible Decisions/Courses of Action:
1. Investigate the variance (to determine its underlying cause(s)).
2. Do not investigate the variance.
Estimated Costs and Probabilities:
1. Cost of investigating the variance =
I
= $5,000.
2. Cost of correcting an out-of-control process (if the process is found to be out of control) =
C
= $10,000.
3. Losses from not correcting an out–of-control process =
L
= $110,000.
4. Probability,
p
, of the process being out of control = 60%
Required:
1. Recast the above information in the form of a payoff table.
2. What is the expected cost of the decision to investigate the variance? Show calculations.
3. What is the expected cost of the decision to not investigate the variance? Show calculations.
4. What is the break-even probability of the process being out of control,
p
, which would make
management indifferent between investigating and not investigating the observed variance?
Demonstrate that, in fact, this is the break-even probability by showing the expected value of
each management action. Show calculations.
164. Management is currently deciding whether or not to investigate a cost variance that was
identified by the accounting system. To help address this question, you have generated the
following data:
Possible States of Nature:
1. The underlying operation is in control (i.e., is operating normally).
2. The underlying operation is out of control (and therefore is in need of an intervention)
Possible Decisions/Courses of Action:
1. Investigate the variance (to determine its underlying cause(s)).
2. Do not investigate the variance.
Estimated Costs and Probabilities:
1. Cost of investigating the variance =
I
= $1,500.
2. Cost of correcting an out-of-control process (if the process is found to be out of control) =
C
= $6,000.
3. Losses from not correcting an out–of-control process =
L
= $50,000.
4. Probability,
p
, of the process being out of control = 15%
Required:
1. Given the above information, what is the expected value of investigating the reported
variance? (Show calculation.)
2. Prepare a payoff table that summarizes the states of nature (i.e., possible outcomes) and the
decision alternatives (i.e., management actions). Your table should include cells for combinations
of management actions and states of nature, plus cells to represent the expected value of each
management action. Which decision is recommended on the basis of information in your payoff
table?
3. Given the above information, what is the probability level,
p
, for an out-of-control process (i.e.,
a nonrandom variance) that would make management indifferent between investigating and not
investigating the variance?
a. In what sense can this probability be considered a breakeven probability? (Demonstrate this
by calculating the expected value of each management action, based on the break-even
probability,
p
, you calculated.) Round final answers to the nearest whole numbers.
b. What is the correct management action if the probability of an out–of-control process is
greater than the break-even probability,
p
? Show all calculations.
165. When implementing a standard cost system, one of the system-design choices that
management must make is choice of the denominator volume level for the purpose of calculating
the fixed overhead application rate, which is used to determine product costs. Various
alternatives exist for the denominator volume.
Required:
1. List and briefly describe the various alternatives that exist for defining the denominator activity
level for product-costing purposes.
2. What provisions of generally accepted accounting principles (GAAP) and current income tax
requirements affect the decision as to choice of the denominator volume level when developing
the standard fixed overhead application rate? Provide an overview of the requirements in this
regard.
166. It can be argued that manufacturing overhead analysis under an ABC system is more
informative or useful to management because of the associated richness of the analysis and
therefore increased potential for cost control. Of particular interest under an ABC system is the
flexible-budget analysis that can be performed when there is a standard batch size for production
activity.
Required:
Explain how the conventional analysis of overhead variances through the use of flexible budgets
can be expanded when production is characterized by a standard batch size. Focus specifically
on the analysis of batch-related costs, for example, production-related set-up costs. Discuss
separately the analysis of fixed setup-related costs and variable setup-related manufacturing
support costs.
167. The variances discussed in Chapter 15 (for manufacturing overhead) are all components
of a short- term financial control system. These variances are calculated using standard
manufacturing costs and flexible budgets. As was argued in the text (both in Chapter 15 and
elsewhere) a financial control system is but part of a more comprehensive management
accounting and control system.
Required:
1. What are the primary limitations of short-run financial control measures?
2. How can a short-run financial control system be expanded to become a more comprehensive
management accounting and control system? Discuss, in at least some detail, how and why you
would expand the system in an attempt to provide management with more useful information.
